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Looking for something to read? See our Reading List; these books, separated by category, are

ones we find interesting and insightful. We will be adding to the list over time.

[Posted: March 31, 2020—9:30 AM EDT] Global equity markets are generally higher this

morning. The EuroStoxx 50 is relatively unchanged from its last close. In Asia, the MSCI Asia

Apex 50 closed up 1.4%. Chinese markets were higher, with the Shanghai Composite up 0.1%

and the Shenzhen Composite up 0.5%. U.S. equity index futures are signaling a flat open.

As March draws to a close today, we’re reminded of the old adage about the month: in like a

lion, out like a lamb. After what we’ve all gone through during the last month, we certainly hope

for a day that’s as quiet and gentle as a lamb! As always, we review all the key news on the

coronavirus epidemic and related, market-relevant items.

COVID-19: Official data show confirmed cases have risen to 801,400 worldwide, with 38,743

deaths and 172,657 recoveries. In the United States, confirmed cases rose to 164,610, with 3,170

deaths and 5,945 recoveries (though the recovery data is lagging). Here is the latest chart of

infections from the Financial Times:

Daily Comment

By Bill O’Grady, Thomas Wash, and

Patrick Fearon-Hernandez, CFA

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• Virology. Two research groups affiliated with the Chinese insurance giant Ping An

(2318.HK, 76.70) yesterday projected that new infections will peak no later than this

weekend in key countries including the United States. The projections seem rosy to us,

especially since they show U.S. infections topping out at just 300,000. Besides, a

respected model from the University of Washington still projects the U.S. peak hospital

usage will come later, on April 15. All the same, we think the Ping An researchers’

model sensibly incorporates factors such as how late the countries started to enforce

social distancing, their population density, the share of their population aged 60+, the

number of intensive-care hospital beds they have available, and the level of public

support for their officials’ lockdown orders. Those markers are probably worth watching

to gauge the future course of the pandemic.

– As serious COVID-19 cases start to overwhelm the medical resources available in

New York City, one of the nation’s top academic medical centers there told

emergency room doctors that they have “sole discretion” to decide whether to

place patients on ventilators or to “withhold futile intubations.” In other words,

rationing.

– China for the first time admitted that its official tally of cases excluded people

who were infected but not showing symptoms. Officials said they will begin

counting asymptomatic cases on Wednesday.

– U.S. spy agencies have been tapped to try to figure out the true incidence and

impact of the virus on China, Russia, North Korea, and Iran.

– In a reminder that human folly, carelessness, or malintent could all be at play

here, reports say U.S. customs officials in recent years have often intercepted

Chinese scientists trying to transport undocumented and undeclared biological

substances – including SARS and MERS samples – into the U.S.

– While the crisis is opening up new opportunities for healthcare firms (especially

in telemedicine), there are also new threats. The heads of the WHO and Unitaid,

a UN-backed group funding global health innovation, are supporting a proposal

that would force companies to pool their intellectual property related to

coronavirus treatment, vaccines, and diagnostics and make them available at low

cost to world governments.

• Real Economy. As consumers continue to stock up on grocery staples, and as production

and logistics systems continue to snarl, global grain prices have jumped 15% or more in

recent weeks, in contrast with the steep price declines for many commodities facing

reduced demand because of the pandemic. However, grain stockpiles are actually

relatively high, suggesting prices could quickly drop again as the crisis passes.

– The All-England Lawn Tennis & Croquet Club meets on Wednesday to determine

whether to hold this year’s Wimbledon Tennis Tournament. Observers expect the

June 29 tournament to be canceled for the first time since World War II.

– As China continues to restart its economy, its official purchasing managers’ index

for manufacturing rebounded to 52.0 in March from its record low of 35.7 in

February. That was a welcome surprise as the index had been expected to remain

significantly below the 50 level that indicates expanding activity. However, even

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the statistical agency warned not to interpret the rebound as a sign that China has

had a “V-shaped” recovery and is now back to full health.

– As if to underline that recovery from the pandemic will be a stop-and-go affair,

some recent moves by Chinese local governments to reopen movie theatres,

tourist attractions, and other venues have been reversed on fears of a rebound in

infections.

• Financial System. New reporting suggests U.S. and European banks are struggling with

about 100 “warehouse” credit lines to collateralized loan obligation marketers. The

credit lines provide temporary funding to CLO managers as they build portfolios of

lower-quality loans that are later marketed to investors. Those assets have now

plummeted in value, leaving the banks with an undisclosed amount of potentially

problematic loans.

• U.S. Fiscal Policy Response. The Treasury Department said the government will begin

sending out stimulus payments to households in the next three weeks, with no action

required for most people. For people who don’t regularly file tax returns, the government

will create a web portal for people to upload their direct-deposit information to the IRS.

Separately, Secretary of Labor Eugene Scalia said the federal government will release the

recently approved funds to boost jobless benefits this week, but how quickly those

payments reach laid-off workers depends on overburdened state unemployment systems.

• Foreign Fiscal Policy Response. Just three weeks after the U.K. released a budget

calling for £156 billion in bond sales in fiscal 2020-2021, the government issued a

revised plan calling for a total of £46 billion in April alone. Separately:

– Klaus Regling, the managing director of the EU’s European Stability Mechanism,

poured cold water on the idea of issuing EU-wide “coronabonds” to finance the

bloc’s response to the pandemic. According to Regling, it would take between

one and three years to set up a new European institution to issue such debt.

However, in an apparent olive branch to hard-hit Italy and Spain, he did suggest

aid in the short term could be funded via existing bodies and instruments.

– Similarly, Eurogroup President Centeno said in a letter to EU finance ministers

that coronavirus aid could be raised using existing institutions and mechanisms,

though “alternatives” could be considered. He also called a meeting of all 27 EU

finance ministers to discuss aid next Tuesday.

– As a reminder, our latest Weekly Geopolitical Report, published yesterday,

examines how the disputes over coronavirus funding have the potential to cause a

breakup of the EU.

• Political Implications. Russia has sent military medical units to Italy in order to help it

deal with the crisis, echoing China’s effort to burnish its image by sending aid abroad.

Separately, Hungary’s parliament gave Prime Minister Viktor Orbán the right to rule by

decree until his government decides the coronavirus crisis has ended.

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Global Oil Market: Two major shale producers in the Permian Basin have asked Texas

regulators to consider curtailing crude output in the state as the industry grapples with collapsing

demand and plunging prices. Meanwhile, poorer oil producers such as Iraq and Venezuela are

being forced to consider steep budget cuts as low oil prices cut deeply into their revenues.

U.S. Economic Releases

The table below shows the economic releases scheduled for the rest of the day.

EDT Indicator Expected Prior Rating

9:00 S&P CoreLogic Case Schiller 20-City House Prices Index m/m Jan 0.4% 0.4% **

9:00 S&P CoreLogic Case Schiller 20-City House Prices Index y/y Jan -2.0% 5.2% **

9:00 S&P CoreLogic Case Schiller 20-City House Prices Index m/m Jan 219.38 218.73 **

9:00 S&P CoreLogic Case Schiller US House Prices Index m/m Jan 3.8% **

9:00 S&P CoreLogic Case Schiller US House Prices Index m/m Jan 212.59 **

9:45 MNI Chicago PMI m/m Mar 40.0 49.0 ***

10:00 Conference Board Consumer Confidence m/m Mar 110.0 130.7 ***

10:00 Conference Board Expectations m/m Mar 107.8 **

10:00 Conference Board Current Situation m/m Mar 165.1 **

Fed Speakers or Events

Economic Releases

No speakers or events scheduled

Foreign Economic News

We monitor numerous global economic indicators on a continuous basis. The most significant

international news that was released overnight is outlined below. Not all releases are equally

significant, thus we have created a star rating to convey to our readers the importance of the

various indicators. The rating column below is a three-star scale of importance, with one star

being the least important and three stars being the most important. We note that these ratings do

change over time as economic circumstances change. Additionally, for ease of reading, we have

also color-coded the market impact section, which indicates the effect on the foreign market.

Red indicates a concerning development, yellow indicates an emerging trend that we are

following closely for possible complications and green indicates neutral conditions. We will add

a paragraph below if any development merits further explanation.

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Country Indicator Current Prior Expected Rating Market Impact

ASIA-PACIFIC

China Composite PMI m/m Mar 53.0 28.9 *** Equity bullish, bond bearish

Manufacturing PMI m/m Mar 52.0 35.7 44.8 *** Equity bullish, bond bearish

Non-manufacturing PMI m/m Mar 52.3 29.6 42.0 *** Equity bullish, bond bearish

Japan Jobless Rate m/m Mar 2.4% 2.4% 2.4% *** Equity and bond neutral

Job-To-Applicant Ratio m/m Feb 1.45 1.49 1.47 ** Equity and bond neutral

Retail sales y/y Feb 1.7% -0.4% -0.2% ** Equity bullish, bond bearish

Department Store, Supermarket Sales m/m Feb 0.2% -1.4% -1.6% ** Equity and bond neutral

Industrial Production y/y Feb -4.7% -2.3% -4.8% * Equity and bond neutral

Vehicle Productoin y/y Feb -3.5% -8.5% * Equity and bond neutral

India Fiscal Deficit INR Crore m/m Feb 51013 53747 * Equity and bond neutral

Australia Private Sector Credit m/m Feb 0.4% 0.3% 0.3% ** Equity and bond neutral

New Zealand Building Permits m/m Mar 4.7% -2.0% * Equity and bond neutral

ANZ Business Confidence m/m Mar -63.5 -19.4 * Equity bearish, bond bearish

Europe

Eurozone CPI m/m Mar 0.5% 0.2% 0.6% *** Equity and bond neutral

CPI Estimate m/m Mar 0.7% 1.2% 0.8% *** Equity and bond neutral

CPI Core m/m Mar 1.0% 1.2% 1.1% *** Equity and bond neutral

Germany Import Price Index m/m Mar -2.0% -0.9% -1.5% *** Equity bullish, bond bearish

Unemployment Change (000's) m/m Mar 1.0k -10.0k 25.0k ** Equity bearish, bond bearish

Unemployment Claims Rate m/m Mar 5.0% 5.0% 5.1% ** Equity bearish, bond bearish

France CPI EU Harmonized m/m Feb 0.7% 1.6% 1.0% ** Equity and bond neutral

CPI y/y Feb 0.6% 1.4% 1.0% * Equity and bond neutral

PPI y/y Feb -0.9% 0.2% * Equity and bond neutral

Consumer Spending y/y Feb -0.6% -0.1% * Equity bearish, bond bearish

Italy CPI EU Harmonized m/m Mar 2.2% -0.4% 1.9% ** Equity bearish, bond bullish

CPI NIC incl. tobacco m/m Mar 0.1% 0.4% 0.0% * Equity bearish, bond bullish

UK GDP y/y 4Q 1.1% 1.1% 1.1% * Equity and bond neutral

Current Account Balance q/q 4Q -5.6 Bil -15.9 Bil -7.0 Bil *** Equity and bond neutral

Switzerland Retail Sales y/y Feb 0.3% -0.1% *** Equity bullish, bond bearish

AMERICAS

Mexico Budget Balance YTD m/m Feb 10.7 Bil 40.8 Bil ** Equity bullish, bond bearish

Canada Bloomberg Nanos Confidence w/w 27-Mar 46.9 51.3 ** Equity bearish, bond bearish

Financial Markets

The table below highlights some of the indicators that we follow on a daily basis. Again, the

color coding is similar to the foreign news description above. We will add a paragraph below if

a certain move merits further explanation.

Today Prior Change Trend

3-mo Libor yield (bps) 145 137 8 Up

3-mo T-bill yield (bps) 4 5 -1 Neutral

TED spread (bps) 142 133 9 Up

U.S. Libor/OIS spread (bps) 7 7 0 Up

10-yr T-note (%) 0.68 0.73 -0.05 Neutral

Euribor/OIS spread (bps) -35 -35 0 Neutral

EUR/USD 3-mo swap (bps) -35 -28 -7 Down

Currencies Direction

dollar Up Neutral

euro Down Up

yen Down Up

pound Down Down

franc Down Up

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Commodity Markets

The commodity section below shows some of the commodity prices and their change from the

prior trading day, with commentary on the cause of the change highlighted in the last column.

Price Prior Change Explanation

Brent $23.63 $22.76 3.82% Economic Optimism

WTI $21.54 $20.09 7.22%

Natural Gas $1.72 $1.69 1.60%

Crack Spread $10.86 $11.01 -1.37%

12-mo strip crack $6.68 $6.46 3.45%

Ethanol rack $1.23 $1.24 -1.05%

Gold $1,598.39 $1,622.51 -1.49%

Silver $13.93 $14.05 -0.82%

Copper contract $217.50 $215.55 0.90%

Corn contract 341.00$ 341.25$ -0.07%

Wheat contract 566.25$ 569.50$ -0.57%

Soybeans contract 878.75$ 882.25$ -0.40%

Baltic Dry Freight 548 556 -8

Actual Expected Difference

Crude (mb) 3.5

Gasoline (mb) 1.6

Distillates (mb) 0.9

Refinery run rates (%) -1.00%

Shipping

Energy Markets

Metals

Grains

DOE inventory report

Weather

The 6-10 and 8-14 day forecasts currently call for cold temps in the west, with warmer-than-

normal temperatures for the rest of the country. Wet conditions are expected for most of the

country.

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Asset Allocation Weekly

Confluence Investment Management offers various asset allocation products which are managed using

“top down,” or macro, analysis. We report asset allocation thoughts on a weekly basis, updating this

section every Friday. Note that this report is also offered as a separate document on our website.

March 27, 2020

We continue to monitor the path of the economy and markets as our expectations for a recession

loom. This week we will update our S&P 500 earnings forecast for 2020.

We use two components to build our forecast for S&P per share earnings. First, we need to

estimate GDP. Normally, we use the GDP forecast from the Philadelphia FRB’s survey of

economists. However, under current circumstances, these forecasts are woefully out of date, so

we are left to our own devices. Any GDP forecast at present is mostly a guess; there isn’t

enough data for March to project any sort of forecast for Q2. Nevertheless, some estimate of

GDP is necessary; our expectation for real GDP is a decline of 5.5% for the year 2020 with a

strong rebound in 2021. This will make the 2020 recession one of the deepest on record and the

deepest yearly recession since 1946. But, it will be short; our estimate suggests that Q2 and Q3

will be negative, with a positive Q4.

-15

-10

-5

0

5

10

15

20

00 10 20 30 40 50 60 70 80 90 00 10 20

YEARLY CHANGE, REAL GDP

Source: Haver Analytics, CIM

YEARLY CHANGE, REAL GDP

Source: Haver Analytics, CIM v

We take this forecast and calculate a nominal GDP number. Second, we use a model to generate

the S&P operating earnings margin relative to GDP. It uses a series of variables, including unit

labor costs, fed funds, NIPA profits/GDP, the euro, WTI, real net exports/GDP and corporate

cash flow. The one variable that has been of particular concern is the comparison of S&P 500

earnings/GDP compared to NIPA profits1/GDP; the modeled difference between these two

variables has widened and, in the past, has signaled an eventual reversion would bring S&P

earnings sharply lower.

1 NIPA stands for “National Income and Product Accounts” and is the formal name of the GDP accounts. As part of that accounting, the Commerce Department calculates corporate profits for the entire economy.

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-4

-2

0

2

4

-2

0

2

4

6

8

1980 1985 1990 1995 2000 2005 2010 2015

DEVIATION S&P OPERATING EARNINGS/GDP

FAIR VALUE FROM NIPA [PROFIT DATA

S&P OPERATING EARNINGS/NIPA PROFITS MODEL

DEV

IATI

ON

PERCENT O

F GD

P

Sources: Haver Analytics, CIM

The deviation line shows that when S&P earnings/GDP is elevated relative to NIPA profits/GDP,

the two tend to correct during recessions. Current levels are elevated; in a recession, history

shows the two series tend to converge.

In our 2020 Outlook Update, we postulated that a recession would occur. Our margin model

shows that S&P earnings will fall to 4.5% of nominal GDP. That lowers our estimate for 2020

S&P operating earnings to 127.00 per share.

-1

0

1

2

3

4

5

6

7

1995 2000 2005 2010 2015 2020

S&P EARNINGS/GDP FORECAST

MARGIN MODEL

RAT

IO

Sources: Haver Analytics, Philadelphia Fed, CIM

MARGIN MODEL

RAT

IO

Sources: Haver Analytics, Philadelphia Fed, CIM

Whenever we make a forecast, we try to determine where the most likely area of error can occur.

We note that in the last recession, the model forecast failed to capture the depths of the earnings

decline. And, in 2016, it didn’t fully account for the energy-related declines. Thus, we may be

underestimating the degree of earnings weakness that may occur. But, for now, we will be using

the 127.00 per share number for 2020, with the caveat that further downgrades are possible. Past performance is no guarantee of future results. Information provided in this report is for educational and illustrative purposes only and should not be construed as individualized investment advice or a recommendation. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Opinions expressed are current as of the date shown and are subject to change.

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Data Section

U.S. Equity Markets – (as of 3/30/2020 close)

-60.0% -40.0% -20.0% 0.0%

EnergyFinancials

IndustrialsMaterials

Real EstateConsumer Discretionary

S&P 500Communication Services

HealthcareConsumer Staples

TechnologyUtilities

YTD Total Return

0.0% 1.0% 2.0% 3.0% 4.0% 5.0%

Energy

Industrials

Financials

Consumer Discretionary

Real Estate

Materials

S&P 500

Communication Services

Utilities

Consumer Staples

Technology

Healthcare

Prior Trading Day Total Return

(Source: Bloomberg)

These S&P 500 and sector return charts are designed to provide the reader with an easy overview

of the year-to-date and prior trading day total return. Sectors are ranked by total return; green

indicating positive and red indicating negative return, along with the overall S&P 500 in black.

These charts represent the new sectors following the 2018 sector reconfiguration.

Asset Class Performance – (as of 3/30/2020 close)

-40.0% -20.0% 0.0% 20.0%

Small Cap

Mid Cap

Emerging Markets ($)

Foreign Developed ($)

Real Estate

Commodities

Foreign Developed (local currency)

Large Cap

Emerging Markets (local currency)

US High Yield

US Corporate Bond

Cash

US Government BondYTD Asset Class Total Return

Source: Bloomberg

Asset classes are defined as follows: Large Cap (S&P 500 Index), Mid Cap (S&P 400 Index),

Small Cap (Russell 2000 Index), Foreign Developed (MSCI EAFE (USD and local currency)

Index), Real Estate (FTSE NAREIT Index), Emerging Markets (MSCI Emerging Markets (USD

and local currency) Index), Cash (iShares Short Treasury Bond ETF), U.S. Corporate Bond

(iShares iBoxx $ Investment Grade Corporate Bond ETF), U.S. Government Bond (iShares 7-10

Year Treasury Bond ETF), U.S. High Yield (iShares iBoxx $ High Yield Corporate Bond ETF),

Commodities (Bloomberg total return Commodity Index).

This chart shows the year-to-date

returns for various asset classes,

updated daily. The asset classes are

ranked by total return (including

dividends), with green indicating

positive and red indicating negative

returns from the beginning of the

year, as of prior close.

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P P/E Update

March 26, 2020

0

5

10

15

20

25

30

70 80 90 00 10 20 30 40 50 60 70 80 90 00 10 20

4Q TRAILING P/E AVERAGE

-1 STANDARD DEVIATION +1 STANDARD DEVIATION

LONG-TERM TRAILING P/E

P/E

Sources: Robert Shiller, Haver Analytics, I/B/E/S, CIM

P/E as of 3/25/2020 = 19.7x

LONG-TERM TRAILING P/E

P/E

Sources: Robert Shiller, Haver Analytics, I/B/E/S, CIM

P/E as of 3/25/2020 = 19.7x

Based on our methodology,2 the current P/E is 20.0x, down 0.3x from last week. The decline in

the P/E was caused by falling index values.

This report was prepared by Confluence Investment Management LLC and reflects the current opinion of the

authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking

statements expressed are subject to change. This is not a solicitation or an offer to buy or sell any security.

2 This chart offers a running snapshot of the S&P 500 P/E in a long-term historical context. We are using a specific measurement process, similar to Value Line, which combines earnings estimates and actual data. We use an adjusted operating earnings number going back to 1870 (we adjust as-reported earnings to operating earnings through a regression process until 1988), and actual operating earnings after 1988. For the current quarter, we use the I/B/E/S estimates which are updated regularly throughout the quarter; currently, the four-quarter earnings sum includes three actual quarters (Q2, Q3 and Q4) and one estimate (Q1). We take the S&P average for the quarter and divide by the rolling four-quarter sum of earnings to calculate the P/E. This methodology isn’t perfect (it will tend to inflate the P/E on a trailing basis and deflate it on a forward basis), but it will also smooth the data and avoid P/E volatility caused by unusual market activity (through the average price process). Why this process? Given the constraints of the long-term data series, this is the best way to create a long-term dataset for P/E ratios.